Effects of Central Bank Intervention on the Interbank Market During the Subprime Crisis

Abstract

We explore whether central bank intervention improves liquidity in the interbank market during the current sub-prime crisis with unique trade and quote data from the e-MID, the only regulated electronic interbank market in the world. Central bank intervention consistently creates greater uncertainty in the interbank market. Prior to the crisis, the cover-to-bid ratio effectively conveys good and bad news from the central bank, but this link is broken during the crisis, suggesting that standard (and special) interventions that do not specifically target interbank asymmetric information fail to improve market liquidity. Our results suggest that the central bank should focus on providing interbank loan guarantees or engage in direct asset purchases rather than simply injecting capital into the system when counterparty risk poses systemic risk to the interbank market.

Forecasting the Intraday Market Price of Money

“…In particular, our results find that long memory approaches, represented by ARFIMA(p,d,q) models where d is the order of integration, provide superior fit-measures and statistically outperforms, in terms of point and density forecasting, random walk, autoregressive and moving average models during periods of high volatilities. Brunetti et al (2011) do not find mean reversion, but their linear specifications might not capture high persistence and nonstationarity modelled by our ARFIMA model. Moreover, our more recent sample where the intraday interest rates reduce in the final part of the sample and lower frequency data could explain the difference.…”

“…Baglioni and Monticini (2012) build up a simple model to explain why in normal times the only friction in action is related to settlement procedures and to the cost of central bank intraday credit (see the above references and VanHoose (1991)), while a liquidity crisis introduces a second component related to the chance of an upward jump of the intraday rate within the day due to some news (e.g., liquidity problems for some players in the market). Furthermore, Brunetti et al (2011) find that central bank interventions during the recent crisis introduced uncertainty and pushed up the intraday money market rate further than (negative) economic news. Durré and Nardelli (2008) show that money market rates have been more sensitive to fine-tuning operations in recent years and Brunetti et al (2011) claim that central banks either did not fully grasp the crowding effect, meaning commercial banks replace money market liquidity with central bank liquidity so that market conditions did not improve, see Heider et al (2009), or consistently underestimated funding liquidity demand.…”

“…Furthermore, Brunetti et al (2011) find that central bank interventions during the recent crisis introduced uncertainty and pushed up the intraday money market rate further than (negative) economic news. Durré and Nardelli (2008) show that money market rates have been more sensitive to fine-tuning operations in recent years and Brunetti et al (2011) claim that central banks either did not fully grasp the crowding effect, meaning commercial banks replace money market liquidity with central bank liquidity so that market conditions did not improve, see Heider et al (2009), or consistently underestimated funding liquidity demand.…”

Norwegian Interbank Market's Response to Changes in Liquidity Policy

“…Allen et al (2009), Affinito (2013, Brunetti et al (2011), Acharya et al (2012) and Gale and Yorulmazer (2013). Our results may therefore be of general interest.…”

What does unconventional monetary policy do to stock markets in the euro area?

“…Beirne et al (2011) study the impact of the first covered bond purchase programme on bond markets. Brunetti, di Filippo, and Harris (2011) find that the non-standard monetary programs lead to higher uncertainty in money markets. Abbassi and Linzert (2012) investigated the impact of ECB's non-standard monetary policy measures on interbank rates and found that it was effective in decreasing Euribor rates by more than 80 bps.…”